Investing money during volatile times

In April, our Investment Committee decided to reduce risk exposure. Yet, ostensibly, the economic and financial environment is improving. We have seen positive momentum in equity markets, the economic slowdown is not as bad as originally anticipated, headline inflation is coming down and central banks are near the end of rate cuts.

So far, China’s reopening is contributing to growth but not inflation. In normal times these signals could provide a reason to increase risk exposure, not reduce it. But these aren’t normal times. Because we aren’t in a bull market, and that means we need to think differently.

America is gradually abandoning its role as the world’s sheriff, a role that has cost it friends. It is a trend that began in 2008 and accelerated since. Like Britain, Spain, France, or even Rome before them, American leaders have discovered that the world is too big to control, even with modern technology. If there’s one thing power hates is a vacuum. Challengers to US primacy and the Dollar have been rising and banding together.

As the world is moving back from unipolar to bi-polar, supply chains need to readapt, and that’s harder than it sounds. Moving factories is the easy part. To construct modern goods, anything from electronics to EV vehicles, raw and processed material from all over the world is required.  Self-reliance of each block depends on successfully rebuilding vast and complex supply chains, quicker than politicians can break the trade binds forged by globalisation. As the two interdependent economies, the US and China, decouple, the consequences are felt across the globe.

This is a world inherently uncertain. And this uncertainty is not cyclical. It’s not about emotion. It’s about structure. So, uncertainty is structural.

Similarly, the world is inherently inflationary. Because lack of supply is not transitory but the result of bigger processes, inflation is not cyclical, but structural.

Central banks have a difficult task. They know that supply chains are not functioning optimally, and that’s not something they can fix. So, to bring prices under control and prevent spirals, they need to bring down demand. But how can you reduce demand for everything, and for a long time at that? Only by reducing disposable income. The process of making people poorer is a very painful one. Some of the tightening has been done in the US due to bank failures. The end goal, lower inflation, might be achieved, but the cost is high.

In a world where things are structurally uncertain, higher inflation and persistently high rates are the base case scenario. The mini-banking crisis may be nearing its end, but higher interest rates tend to uncover more areas of weakness fostered by an unusually long and liquid cycle.

So while short-term signals are good, larger forces are at play, and the lack of a clear catalyst for the next bull market forces us to see the uptick as cyclical. The basis of investment is mean reversion. In a bull market, mean reversion means a return to an upward trend. In a volatile and trendless market, mean reversion means a return towards a sideways trend.

A bullish signal in a bull market is a buy signal. A bullish signal in a trendless market is a caution signal. Therefore, investing like this requires discipline, compelling us to constantly question whether we are in a bull market, a bear market, or, as we think is the case, a volatile market in search of long-term drivers.

All signals should be seen not in isolation, but under that particular prism.

George Lagarias, Chief Economist